An Equilibrium Asset Pricing Model with Labor Market Search
Carnegie Mellon University - David A. Tepper School of Business
Carnegie Mellon University - David A.Tepper School of Business
Ohio State University - Fisher College of Business; National Bureau of Economic Research (NBER)
January 18, 2013
Fisher College of Business Working Paper No. 2012-03-001
Charles A. Dice Center Working Paper No. 2012-1
Frictions in the labor market are important for understanding the equity premium in the financial market. We embed the Diamond-Mortensen-Pissarides search framework into a dynamic stochastic general equilibrium model with recursive preferences. The model produces realistic equity premium and stock market volatility, as well as a low and stable interest rate. The equity premium is countercyclical, and forecastable with labor market tightness, a pattern we confirm in the data. Intriguingly, three key ingredients (small profits, large job flows, and matching frictions) in the model combine to give rise endogenously to rare disasters `a la Rietz (1988) and Barro (2006).
Number of Pages in PDF File: 59
Keywords: Search frictions, equity premium puzzle, rare disasters, time-varying risk premiums, dynamic stochastic general equilibrium, unemployment, labor market tightness
JEL Classification: E21, E24, E40, G12working papers series
Date posted: January 4, 2012 ; Last revised: January 18, 2013
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